Note: I am travelling (ancient word: “go from one place to another, typically over a distance of some length”) in Europe until August 23rd. Postings will thus be sporadic, limited and time-zones impacted.

U.S. Empire State Manufacturing Index Plummets in August; Lowest Since May ’20

The Empire State Manufacturing Index of General Business Conditions plunged to -31.3 in August, down from 11.1 in July and -1.2 in June, according to the Empire State Manufacturing Survey released by the Federal Reserve Bank of New York. The Action Economics Forecast Survey had expected a positive reading of 5.0.

The August negative result, down from 18.3 in August 2021, was the lowest level since May 2020’s -48.5. (…)

Haver Analytics constructs an ISM-adjusted Empire State diffusion index using methodology similar to the ISM series and information from five component indexes in the survey. The index fell to 45.9 in August from 57.3 in July and 56.7 last August, indicating activity contracted for the first time since August 2020 to the lowest level since May 2020’s 40.5.

The new orders index dropped to -29.6 in August, the lowest reading since May 2020, from 6.2 in July and 14.8 in last August. (…)

The unfilled orders index dropped to -12.7 in August, the lowest level since August 2020, from -5.2 in July and 15.0 last August. The delivery times index fell to -0.9 in August from 8.7 in July, with a lessened 18.2% of respondents reporting higher delivery times and an increased 19.1% of respondents reporting lower delivery times. The inventories index dropped to 6.4 in August from 14.8 in July, registering the lowest reading since 6.2 last August.

The number of employees index decreased to 7.4 in August, the lowest level since April, from 18.0 in July and 12.8 last August. (…) The average workweek slid to -13.1 in August, the lowest reading since May 2020, from 4.3 in July and 8.9 last August.

Inflation pressures eased a bit this month. The prices paid index declined to 55.5 in August, the lowest reading since January 2021, from 64.3 in July and 76.1 last August; thus, suggesting a deceleration in input price increases. Nearly sixty-one percent of respondents reported higher prices paid in August, while 5.5% reported lower prices paid.

The prices received index was at 32.7 in August, slightly up from 31.3 in July but down from 46.0 last August. About thirty-six percent of respondents reported higher prices received in August, while only 3.6% reported lower prices received.

The indexes of expected conditions in six months were mixed. The index for future business conditions rebounded to a still-low 2.1 in August after falling 20.2 points to -6.2 in July, indicating firms were not optimistic about their six-month outlook. Expectations for new orders (14.0) and shipments (18.7) improved but remained at low levels. Expectations for employment picked up to 30.0 in August from 22.5 in July. Expected delivery times declined to -12.7 from -9.6. Expectations for capital spending and technology spending eased slightly, to 12.7 and 10.0, respectively.

  

U.S. Home Builder Index Extends Downward Trend

The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo declined 10.9% during August (-34.7% y/y) to 49, the lowest level since May 2020. The index is down 45.6% from its November 1990 high of 90. A reading of 55 had been expected in the INFORMA Global Markets survey.

All three HMI components continued to decline this month. The index of present sales conditions fell 10.9% (-29.6% y/y) to 57, the seventh decline in eight months. It followed a 15.8% July decline. The level was 40.6% below the record-high 96 in November 2020. The index of expected sales over the next six months weakened 4.1% (-42.0% y/y) to 47, the seventh monthly decline this year. It stood at the lowest level since May 2020, off 47.2% from the November 2020 peak.

The index measuring traffic of prospective buyers eased 13.5% (-45.8% y/y) to 32, the seventh m/m decline this year.

Each of the regional index readings weakened this month. The index for the Midwest fell 14.3% (-34.4% y/y) to 42 in August, down every month but two this year. The index for the Northeast declined 14.0% (-35.5% y/y) to 49, off 43.7% from the February 2021 peak. The index for the West was off 10.6% (-50.6% y/y), down 57.1% from the November 2020 peak. In the South, the index weakened 10.0% (-29.9% y/y) to 54, the seventh monthly slide this year. The regional series begin in December 2004.

• Canadian Housing Correction Accelerates, Prices Seen Falling 25% Royal Bank of Canada has predicted this will be the biggest real-estate correction Canada has seen in at least 40 years. National sales and price data for July are due next week, with Toronto already reporting a 3.9% decline in its home-price index on the month — capping its worst four-month drop since 2005.

China’s Growth Slowed, Prompting Surprise Rate Cut Economic activity worsened across the board in July, highlighting the breadth of the challenge facing policy makers in a politically sensitive year for leader Xi Jinping.

• John Authers: China Surprise Data Could Spell R-e-c-e-s-s-i-o-n

(…) People were entitled to be surprised about this. Only last week, the People’s Daily, mouthpiece of the Communist Party, ran this piece that opened as follows:

“China’s central bank is expected to pay more attention to keeping inflation in check during the rest of the year while sustaining support for economic growth, experts said on Thursday. Given the necessity of maintaining price and financial stability, the possibility of cutting policy interest rates in the coming months has declined.”

(…) It’s not long since problems for the Chinese economy were regarded as a positive for the rest of the world, because these would prompt another big credit-fueled stimulus. But without sufficient demand for credit, any monetary stimulus could be like pushing on a string. As Marko Papic of Clocktower Group shows, the interest rate on one-month bank notes has dropped to zero, implying minimal demand for credit. (…)

Chinese authorities also have to contend with the ongoing fallout from the fall in property prices, which has continued unabated for almost a year, and the difficulties for property developers. The problems for China Evergrande Group briefly prompted a spasm across world markets late last year, but have now largely left the headlines. Evergrande’s issues are still intense, however. Indeed, the yield on its bonds maturing in 2025 is now over 150%. (…)

If none of this sounds healthy, that’s because it isn’t. And yet stock markets in Europe and the US managed to register gains for the day. That sounds worryingly insouciant.

The Chinese military tests around Taiwan appear to have been quickly forgotten, at least on markets — and there are good reasons to believe that China simply can’t afford to try to take over the island now, as George Magnus explains in this piece. But the lack of any great market reaction to the Shanghai Surprise is concerning. At one level, a slowing China helps to bring down commodity prices (down almost across the board on Monday), which helps defeat inflation. But there was a hope that inflation could be beaten without too much pain for economic growth. A serious Chinese slowdown would make a global recession much harder to avoid, and should be bad news for stock markets.

• “We’ve never seen a property market slowdown of this size and severity.”— Logan Wright, director of China markets research at Rhodium Group to the WSJ, on China’s increasingly deteriorating property bubble, which is compounding its economic woes.

• China’s economic weakness goes beyond real estate Real estate property construction, home sales and mortgages are just part of the weaknesses we have seen in the Chinese economy. Export demand could also weaken in the coming months. This will derail job growth in China, creating a vicious cycle on consumption and economic growth despite Covid measures becoming more flexible

Just when you thought things couldn’t get worse in Germany… This summer break has not helped to improve the German economy’s outlook. To the contrary, two new risk factors can be added to the long list of risks and challenges: low water levels and a gas levy. It will need an economic miracle for Germany not to fall into recession in the second half of the year

Note: I am travelling (ancient word: “go from one place to another, typically over a distance of some length”) in Europe until August 23rd. Postings will thus be sporadic, limited and time-zones impacted.

John Mauldin’s recent Thoughts From The Frontline covers a lot of ground in the current uncertain, rather puzzling, environment.

(…) Markets evidently think the Fed will stop hiking sooner rather than later. They are literally not paying attention to what multiple Fed officials are saying in speeches all over the country. Let’s look at what normally uber-dove Neel Kashkari says:

“The idea that we’re going to start cutting rates early next year, when inflation is very likely going to be well in excess of our target, I just think it’s unrealistic,” Minneapolis Fed president Neel Kashkari said.

He further stated that, “I think a much more likely scenario is we will raise rates to some point and then we will sit there until we get convinced that inflation is well on its way back down to 2% before I would think about easing back on interest rates.” He went on to state that the Fed “is far away from declaring victory on inflation, and while this is the first hint that price movements are moving in the right direction, it doesn’t change my path for rates.” (…)

We are in uncharted waters. The Fed is raising rates into an inverted yield curve and has clearly expressed its intention to continue doing just that. (…)

The yield curve is flashing a strong recession signal three to four quarters out. What makes this curious, and a little more difficult to predict, is that we already have a stagnant/negative growth with two straight quarters (if revisions show Q2 still negative) of declining GDP.

Inversions typically precede recession by anywhere from a few months up to two years. The yield curve is usually back to normal by the time recession actually arrives. But nothing about all this is “typical” so maybe this time is different.

Or more likely, the real recession is still coming. (…)

Last week my friend/business partner Steve Blumenthal flagged a report from Bridgewater’s Bob Prince on “Transitioning to Stagflation,” an ominous but probably accurate title for where we are headed. Here’s the core of it.

(…) “The markets are discounting a very different scenario. They are discounting one sharp round of tightening—comprised of a rise in short-term interest rates to just above 3%, combined with more than $400 billion of contraction of the Fed’s balance sheet—and that this will be enough to bring inflation down to 2.5% with stable growth and no dent in earnings. From there, markets are discounting that the achievement of these goals would allow a subsequent 1% drop in rates from their peak.

“Asset returns are driven by how conditions unfold in relation to what is discounted. Our approach is to have an excellent reading of current conditions and a time-tested understanding of the cause/effect linkages, leading to a reliable probabilistic assessment of what comes next: an optimal response to known conditions. Today, our indicators suggest an imminent and significant weakening of real growth and a persistently high level of inflation (with some near-term slowing from a very high level).

Combining this with what is discounted, the difference between what is likely to transpire in the near term and what is discounted is the strongest near-term stagflationary signal in 100 years, shown below. Longer term, as we play it out in our minds, we doubt that policy makers will be willing to tolerate the degree of economic weakness required to bring the monetary inflation under control quickly. More likely, we see good odds that they pause or reverse course at some point, causing stagflation to be sustained for longer, requiring at least a second tightening cycle to achieve the desired level of inflation. A second tightening cycle is not discounted at all and presents the greatest risk of massive wealth destruction.”

^{Data estimated through June 2022. Estimates based on Bridgewater analysis.}
Source: Bridgewater Associates

The Bridgewater report goes on to describe how all this tightening will unfold and what it needs to do in order to bring inflation down to the 2.5% area. They expect about two more years of tightening to reach that point.

Markets aren’t priced for anything like that scenario. This means, among other things, mortgage rates will continue to choke the housing market, with substantial knock-on effects including many lost jobs.

That won’t be an accident. It’s what the Fed wants. (…)

How this goes depends a lot on the next few economic reports. Currently the federal funds rate, the Fed’s primary policy rate, is at 2.5%. It will likely be at least 3% after the September meeting, maybe higher if August inflation and jobs data remain strong. It’s easy to imagine 4% by year-end if inflation isn’t falling fast enough. They need to get real rates to a positive number, at least, and that is probably a lot higher than 4%.

A yield curve starting at 4% and bending down to 2.5% 10-year yields is possible, I suppose, but I can’t imagine it staying that way very long. Some combination of yields needs to move differently.

One possibility is long-term yields rise, restoring normal slope to the yield curve. That would mean higher mortgage rates, with all the attendant economic damage, as well as higher interest costs on the federal government’s gargantuan debt. Hardly benign—but quite possible with QT about to begin in earnest.

Note also that Charles Evans, another FOMC dove, said last week that “we must be increasing rates the rest of this year and into next year.” So much for data dependency.

Goldman says that “bringing down wage growth and inflation, shows little convincing progress so far. Wage growth has moved sideways at 5.5%, 2pp above the 3.5% pace that we estimate is compatible with 2% inflation. On inflation, the good news is that falling commodity prices and supply chain recovery are delivering a long-awaited and much-needed disinflationary impulse from the goods sector. The bad news is that high inflation is broad-based, measures of the underlying trend are elevated, and business inflation expectations and pricing intentions remain high.

Investors cheered a surprisingly strong payroll report, with continued wage pressures, then cheered again at a surprisingly soft inflation report. A strong “disinflating” economy with 5%+ wage gains?

Meanwhile, Q2 corporate results keep surprising on the upside, but mostly due to higher energy and commodity prices. Otherwise, the severe margins squeeze that started in Q1 has continued in Q2 and is forecast to remain through the rest of the year.

Recall the very bad productivity data released last week. Revenue growth will no doubt shortly slow below unit labor costs (+10.8% YoY in Q2) as companies pay the cost of hoarding labor.

David Rosenberg questions the apparent strength of the economy:

Please — as if there was anything going on in the economy to tell anyone that there truly was a +528k employment surge in June. The historical odds of seeing this with both the manufacturing and service-sector ISM employment subindices below zero is zero.

Jobless claims have trended higher and already flashed the recession signal. Challenger layoff announcements are soaring.

The Household survey has flashed successive declines in full-time jobs and a spike in multiple job holders, which is a classic counter-cyclical indicator (along with sharply accelerating usage — +20% at an annual rate these past four months in revolving credit balances). Within that nonfarm payroll report, more than 150k of the jobs came from the “birth-death” model even though business creation has contracted by 8-1/2% from a year ago.

This is why nonfarm payrolls take a back seat to the Household survey — in both directions — at turning points of the economic cycle. Heading into recessions, the payroll survey overestimates net new business creation and the skew this gives to the headline data, and the opposite when the recession swings to expansion.

Go back to the 2008-09 recession as an example. After the BLS “corrected” the flaw in its model, the combined level of employment ended up being revised to show more than 1 million jobs vanished compared to the initial estimate! A downward revision (the data for over 90% of the months in the Great Recession were ultimately revised down!).

Go back to this last pandemic/lockdown recession — the March 2020 payroll number today stands 672k lower than the initial “take” by the BLS! This is what the Fed stakes its ground on and what traders react to?? Come on.

Whatever one looks at, data has surprised one way or the other but their reliability is questioned. So much for a data dependent Fed.

In truth, nobody really knows the future course of the critical variables, inflation, employment and interest rates, although on the latter, FOMC members and Mr. Powell are insistent on their likely and desired journey.

EARNINGS WATCH

Through Aug. 12, 456 companies in the S&P 500 Index have reported earnings for Q2 2022. Of these companies, 77.6% reported earnings above analyst expectations and 18.2% reported earnings below analyst expectations. In atypical quarter (since 1994), 66% of companies beat estimates and 20% miss estimates. Over the past four quarters,81% of companies beat the estimates and 16% missed estimates.

In aggregate, companies are reporting earnings that are 6.1% above estimates, which compares to a long-term (since1994) average surprise factor of 4.1% and the average surprise factor over the prior four quarters of 9.5%.

Of these companies, 69.3% reported revenue above analyst expectations and 30.7% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 78% of companies beat the estimates and 22% missed estimates.

In aggregate, companies are reporting revenues that are 2.9% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.2% and the average surprise factor over the prior four quarters of 3.4%.

The estimated earnings growth rate for the S&P 500 for 22Q2 is 9.7%. If the energy sector is excluded, the growth rate declines to -0.9%.

The estimated earnings growth rate for the S&P 500 for 22Q3 is 5.8%. If the energy sector is excluded, the growth rate declines to -0.9%.

China: July activity data broadly missed expectations

July activity data broadly declined from June and surprised markets to the downside, reflecting weak domestic demand amid sporadic Covid outbreaks, production cuts in some high-energy consuming industries and adverse impact of some risk events in the property sector, despite incremental policy support and favorable base effects. Industrial production rose by 3.8% yoy in July (vs. +3.9% in June), below market consensus of 4.3% yoy.(…)

Retail sales growth moderated to a weaker-than-expected +2.7% yoy in July from +3.1% in June, with Covid-sensitive catering sales growth remaining negative at -1.5% yoy. Fixed asset investment growth declined to +3.6% yoy in July from +5.9% in June on a single month basis, also weaker than expectations despite more infrastructure stimulus.

That said, surveyed unemployment rates edged down in July, suggesting labor market pressure has eased sequentially on more policy support.

On the back of weaker-than-expected activity, credit and inflation data, as well as recent risk events in the property sector, the PBOC cut its policy rates by 10bp this morning, in an effort to boost bank lending, economic growth and market sentiments. (GS)

CAPITULATION?

According to GS Prime, this rally has now become the 3rd biggest hedge fund short covering event in the last decade. (The Market Ear)

• On balance volume continues to refuse buying this latest melt up.

FYI: